Switching to the current year basis – the impact on sole traders, Partnerships and LLPs
Stephen Kenny (pictured) from Blick Rothenberg’s Financial Services team reviews HM Revenue & Customs’ (HMRC) recent announcement on moving the accounting year end for unincorporated businesses.
What has been announced?
HMRC has announced that unincorporated business (sole traders and Partnerships, including Limited Liability Partnerships) will move from the accounting year basis to the current year basis.
This is expected to apply from 2023/24, with 2022/23 as a transitional year.
What does this mean?
At present, businesses are taxed on the profit of the accounting year ending in the tax year ie, if a Partnership prepares its accounts to 31 December in the 2023/24 tax year, the members will be taxed on the profits made in the year to 31 December 2023.
Under the current year basis everyone will be taxed on the profits made in the 2023/24 tax year, meaning they would be taxed on 9/12 of the profits for the year ended 31 December 2023 and 3/12 of the profits for the year ended 31 December 2024.
Businesses who already make their accounts up to the 31 March or 5 April will not be affected by this change.
Is this good or bad?
HMRC’s position is this is a simplification of the tax system.
Some 93 per cent of sole traders and 67 per cent of partnerships draw their accounts up to the tax year (or 31 March), and as such a transition to the current year basis would have no impact for them.
It would eliminate the problem of overlap profits. This is where a business has a different year-end to the tax year and some profits are taxed both in the year of commencement and a subsequent tax year.
Overlap profits can be an issue for Partners joining existing profitable Partnerships. With the current year basis, no future overlap profits would be generated. Existing businesses with overlap profits would be eligible for relief during the transition year.
HMRC also expect that many affected businesses will choose to change their accounting date to 31 March to avoid further issues.
However, this will not be possible for a number of businesses who have chosen different year ends for commercial reasons, including:
- UK Partnerships that are part of international businesses (for example, UK offices of US law firms)
- Private Equity/Venture Capital/Asset Managers who have their year-end aligned with their funds’ year-end
For businesses that do not change their year-end, they will be required to apportion the profit from relevant accounting periods to the tax year.
This will create new and recurring administrative burdens for businesses with non-tax year accounting dates. While HMRC consider apportionment a simple, arithmetical process, this will not always be the case. Where apportionment wouldn’t give an accurate result, an alternative basis could be used if it is used reasonably and consistently.
Where a business has a 31 December year-end, they are unlikely to have finalised their accounts in time to file their tax return. This means that there are going to need to be estimates and returns filed on a provisional basis and amending the tax return once the figures are finalised. This will be an ongoing additional burden on the taxpayer. Businesses with December year-ends may want to consider if it better to use actual figures rather than apportionment.
In the year of transition, this could create significant additional tax liability for some, as there may be an inclusion of additional profits to ensure all profits from the tax year are accounted for. This means that there will be an acceleration in the tax payable on profits. It may also push some into a higher tax bracket.
While in the transitional year they will be able to deduct any overlap profits, this will be less helpful where business profits have increased since the individual started the business or joined the partnership.
To ease this burden, HMRC is considering an election to allow those with higher profits to spread the additional profits over up to five years. This would run the risk of these profits being subject to higher tax and National Insurance if tax rates increase. Affected business may want to consider the impact this will have on cashflow and how much they should be setting aside.
At present, these changes are not law and are subject to consultation, which ends on the 31 August and as such, there may be further changes ahead. However, HMRC seems keen to push through these changes before ‘Making Tax Digital for Income Tax Self Assessment’ becomes mandatory from April 2023. Therefore, we consider it very likely that these (or very similar) rules will be introduced.
While for the majority this will be a welcome simplification, these rules are likely to cause the most disruption for:
- businesses which are unable to change their year-end for commercial reasons, or
- international firms and those who have more difficulty estimating the profit share due to year-ends in the last quarter of the year and those who will find apportionment more difficult/unsuitable due to fluctuation/seasonal profits.
If you have any questions about the change to the current year basis or would like to discuss how it will affect your business, please contact Stephen Kenny.